We listened-in last week on a webcast hosted by the corporate credit team at Wells Fargo. Overall, their assessment of the market was cautious, as leverage has ticked up and certain sectors such as materials and energy are showing significant weakness. They characterize the current market as falling into the late stage of a typical credit cycle, where credit fundamentals deteriorate as debt increases and profits peak. As such, they have increased their year-end spread target for investment grade corporates to 1.85% versus an original forecast of 1.45% and are recommending a market weight to the sector.
We largely agree with their overall view and believe that caution is indeed warranted whenever fundamentals show signs of weakness. However, there are many reasons to get excited about certain sectors and maturity ranges in the market. Much of the weakness in credit fundamentals has been driven by industrial companies, particularly in healthcare, where merger and acquisition activity has driven huge debt issuance. Other sectors, such as financials, are enjoying strong fundamental credit quality. In addition, bonds maturing on the front end of the yield curve (5 years and in), have strong technical properties that insulate their total return from a spread widening environment. Wells Fargo’s credit team is well respected, and it is likely that we will begin to see news articles warning about the dangers of corporate bonds. Remember, behind every headline are scores of important though subtle nuances, which is especially true here.
Source: Wells Fargo